Leo Melamed: The market maker

Michael R. Schmidt

Leo Melamed, chairman and CEO of Melamed & Associates Inc. and chairman emeritus of the Chicago Mercantile Exchange, invented the financial futures market. The John Marshall Law School graduate said he “came to the conclusion that an education in law is the finest education anyone can get, because it teaches you to think.” Here, he stands in the 40,000-square-foot Globex Control Center.

They’re all posing with Leo Melamed, the chairman emeritus of the CME who invented the financial futures market, which today comprises hundreds of trillions of dollars in trade globally.

Across from this living history gallery and on the bookshelf right above Melamed’s computer is a simple black-and-white photo of a Japanese man seated at a desk with a book.

Chiune Sugihara rarely appears in history books, but the Japanese diplomat helped save Melamed’s life 74 years ago when the 8-year-old Melamed and his family were Jewish refugees running from the Nazis during World War II.

Throughout his career, Melamed has advised world leaders in countries such as Germany, Russia and China on building their financial markets. The attorney-turned-trader also developed the first global electronic futures trading platform in the world, Globex, in 1992.

All of it stems from the actions of that one man, three generations ago.

“It couldn’t have happened if not for Sugihara,” Melamed said. “He gave me life, to do with it what I was talented to do.”

To Japan and back again

After narrowly escaping the Nazis in their home country of Poland in 1939, Melamed’s family left Lithuania in the fall of 1940.

Although Sugihara was ordered by the Japanese government not to aid Jewish refugees, he told his family, “If I follow the dictates of my government, I will violate the dictates of my God.”

The diplomat issued transit visas from Lithuania to Japan that saved nearly 6,000 Jews from death.

“Clearly, this was one unusually courageous man whose moral fiber is to be exemplified for the world,” Melamed said. “It’s an unbelievable story of courage beyond duty.”

The refugees took a harrowing three-week journey across Russia on the Trans-Siberian Railway.

Melamed’s father was a well-known socialist, and throughout their journey, socialists were arrested and taken off the train by Soviet authorities. His parents constantly feared they would be discovered.

Once they reached the eastern seaport of Vladivostok, the refugees took a three-day boat ride to Tsuruga, Japan. Melamed and his family stayed in Kobe, Japan, for four months until they were granted permission to immigrate to the U.S.

Melamed went to Japan in July as part of events to honor Sugihara, who is remembered today among Holocaust humanitarians such as Oskar Schindler and Raoul Wallenberg and recognized as “Righteous Among the Nations” — a distinction conferred on non-Jews who acted heroically during the Holocaust — by Yad Vashem, the Holocaust Martyrs’ and Heroes’ Remembrance Authority in Jerusalem.

He did find time, though, to also discuss business ventures.

The highlight of his trip was meeting Japanese Prime Minister Shinzo Abe and discussing the possible creation of a liquefied natural gas contract in the futures market in Japan. Melamed said the prime minister urged him to continue that effort with Japan’s Ministry of Economy, Trade and Industry.

After the 2011 Fukushima Daiichi Nuclear Power Plant disaster, Japan has moved away from nuclear power as an energy source and is now reliant on natural gas, which is expensive to import.

“They believe that if they had a natural gas contract as a trading activity in Tokyo, it would allow them to be part of the discovery price process and therefore lower the price of natural gas,” he said. “And that would force everyone to lower the price to them as well.”

That serious conversation about the futures market is a far cry from what Melamed first experienced when he broached the idea for a financial futures market in Chicago more than 40 years ago. Today, the futures market comprises more than half of the financial industry.

“At first, the whole world laughed at me and thought I went off the deep end. But because Milton Friedman supported it, it gave me the credibility I needed,” he said. “It was the exact, perfect move to prove that even a lawyer can come up with a good idea every now and then.

“And I changed the nature of finance.”

Creating a new market

Before 1972, currency markets worked on a fixed exchange-rate system, and currency exchange rates were determined infrequently by international finance ministers.

But the markets were constantly moving, and therefore the value of currency changed every day. The speed of information by the 1970s added to that frequent fluctuation as news from around the world could affect trading on the floor.

The original futures market was limited to agriculture. For example, buyers locked in a rate for a deliverable product such as bushels of wheat in a futures contract.

Once the wheat was ready for the market in six months, the value of it may have increased or decreased, depending on supply and demand. Either way, the initial price was insured for the buyer through a bank or a clearinghouse like the Chicago Mercantile Exchange.

The contract can generate either a profit or a loss, but the seller is still guaranteed the price at which he or she sold forward six months before. Known as a hedge, the concept protects farmers in the event prices fall. It also provides speculators an opportunity for profit.

Melamed thought futures contracts could be used for financial transactions, helping hedge risk and provide stability for a buyer. Or it could be used to speculate, as a buyer tries to profit from rising or falling exchange rates.

If currency became an open market and traded through futures contracts, Melamed thought, it could open up the same hedging opportunity for people in international business. That could create new markets and increase liquidity. There would be no deliverables, just cash settlements.

Melamed brought his idea for an international monetary market to the CME board.

“I was laughed out of the board room because I was in my 30s at the time and everybody else was in their 130s,” he said. “And I was going to ruin the exchange — which is a statement laughable in itself, since the exchange wasn’t much to ruin.”

At the time, the CME was a small organization focused on agricultural trading such as eggs, onions and pork belly contracts. Melamed said it operated like the Wild West when he inherited it as chairman in 1969, and he credits his background as an attorney with helping him tame it.

Becoming a trader in itself was a happy accident for Melamed.

While a student at The John Marshall Law School, he was looking for a job as a law clerk when a friend called and said he saw an ad in the paper for a part-time position at Merrill, Lynch, Pierce, Fenner & Bean.

“That must be a law firm with those names struck out like that,” his friend told him. “What else could it be?”

The young Melamed still didn’t know it was a brokerage firm until he arrived at the CME trading floor on his first day of work. The energy on the floor captivated him.

“The job was as a runner, running the orders from the desks to the books to be executed,” Melamed said. “I took the job and landed on the Merc floor, and what I saw, I loved. It was instant love.”

He stuck with the job through law school, and after he turned 21, he borrowed $3,000 from his father to become a CME member so he could trade. Melamed graduated in 1955, went into private practice and continued trading part time until he realized he enjoyed the trading pits more than the courtroom.

When he became chairman in 1969, Melamed noticed the CME had no solid rule of law underpinning its operations.

The master rule book was a loose-leaf binder with hundreds of amendments typed onto slips of paper and taped onto the pages. Longer changes were stuffed into the book on separate pieces of paper, and some items were handwritten in the margins.

To bring order to the chaos, Melamed had a “constitutional convention” and spent a year working on the rule book with Jerrold E. Salzman, who is now of counsel at Skadden, Arps, Meagher & Flom LLP and outside counsel to the CME.

In the years that followed, Melamed’s law background helped him navigate federal regulations and negotiate with financial world leaders.

“I came to the conclusion that an education in law is the finest education anyone can get, because it teaches you to think,” Melamed said.

“It doesn’t matter if you end up to be a truck driver or a jurist in court. It teaches you to think and to organize your thoughts in a way that was logical and reasonable.”

After the CME board ignored his initial proposal for a currency futures market, Melamed knew he needed the support of an economist. He turned to one of his heroes, Friedman — who would later win the Nobel Prize in economics — for help.

Friedman wrote a feasibility study endorsing the idea and, with his backing, the CME board launched the International Monetary Market (IMM) in 1972.

“It was clearly a good idea, an interesting idea — and the long term future, if it worked, was unlimited,” Salzman said.

It worked.

Financial futures opened the doors to trading in interest rate futures, Eurodollars, U.S. Treasury bills, Standard & Poor’s 500 Index contracts and countless other financial instruments that are at the core of today’s global financial industry.

Cosmic idea inspires Globex

Melamed has written four books, and his memoirs have been translated into other languages. In his science fiction novel, “The Tenth Planet,” a super computer named Putral performs an unlimited number of functions at once, from running a railroad to brokering peace agreements.

Melamed was sitting at his desk on the floor of the CME in 1986 watching runners dash back and forth across the floor with orders when he thought of his fictional alien world and Putral.

“You know,” Melamed thought to himself, “you just had the imagination to invent a computer that could do all this, and you think you couldn’t create a more efficient system with a computer to run the orders back and forth? Why not?”

Thus, the idea for an electronic transaction system in futures was born. Melamed introduced Globex in 1987.

Although other markets were slowly becoming automated, Globex was a tougher proposal for the CME. Many members feared the automated system would take away jobs from brokers.

He had to guarantee CME members that existing markets wouldn’t be traded on Globex, and only new markets would be introduced on the system. It took five years of work before it launched in June 1992.

Globex increased the speed of futures trading and allowed it to happen nearly around the clock, something that was crucial to being competitive in the growing global economy.

Despite the success of electronic trading in other U.S. markets and Europe, little happened on Globex in its first few years. The CME board brought Melamed out of retirement to push the platform forward, and it took more than a decade before it was fully integrated at the exchange.

Jack Gould, a University of Chicago professor of economics, said Melamed is a visionary because he realized the significance of creating the financial futures market and the importance of moving the CME to Globex.

“When you have a big change like that in an industry, people are afraid,” he said. “He provided great leadership in that challenge.”

Prior to Globex, the CME barely reached a million transactions a year. Today, it does more than 11.1 million transactions a day.

“I got death threats at the time during those 10 years, but I never doubted for a moment that I was right and that the world was going to an electrified world and automation,” Melamed said. “And had we not moved that way, we wouldn’t have a CME group today.”

That never-give-up attitude has been a key to Melamed’s success, Salzman said.

“If Leo has an idea that he thinks is a good idea, he can be told 1,000 times no and still get it done,” he said. “And he has good ideas, and when you put those two things together, you’ve got an unstoppable force.”

The future of futures

Despite the 2008 market crash, Melamed still has faith in the market. Because currency futures are cleared at the end of a trading day in a mark-to-market system, the financial futures market didn’t default the way other markets did.

“If we destroy capitalism, we’re going to suffer,” he said. “Because history has shown there is no better system.”

China is a good example of a strong, emerging market, Melamed said. In the past 30 years, the country moved from “absolute nothing to a modern behemoth in economics,” he said, because of the way the country developed its economy and lifted thousands out of poverty and into the middle class.

He attributes the success of emerging markets in countries such as China, Japan and Singapore to their focus on higher education to advance their economies.

“They believe in education, and you can’t beat that,” he said. “That’s why I’ve devoted so much of my time at the Merc for educational purposes in the United States particularly in Illinois.”

At John Marshall, he endowed the Melamed Fellowship in International Business and Trade Law. Since 2001, it has been awarded every two years to a student in the school’s LL.M. program in international business and trade law and includes a one-half tuition payment, a paid research assistantship with the Center for International Law and a $10,000 stipend.

When he visited Japan, Melamed also spoke at a few schools and Waseda University to share Sugihara’s story.

“My message was that one person can change the world. That it’s not true that you need the masses,” he said. “The deeds of one person can change the world, and here’s proof of it.”

Sugihara’s bravery, Melamed said, allowed him to make his own mark on history. Melamed wants his legacy to be as an innovator who was willing to take chances and turn ideas into reality.

“Ideas come and go, but ideas that are executed — in other words, instituted — are the ones that are most important,” he said.

“You can’t just launch an idea and expect the world to necessarily adopt and put it into work. But the person that can do that is really doing something for civilization.”